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Why we need to invest in Equity?

Every now and then there is a question which I get asked.  Why should somebody invest in Indian Equity at all?  Can’t they happy investing in Fixed Deposits, Real Estate, Gold and others.  There are number of people who haven’t considered Equity as an asset class and this article is precisely for them.  I want to impress upon people the need to be invested in Equity through my blogpost.
The fundamental premise for investing in equity is to take advantage of the  famed India growth story.  As a country, we continue to grow and develop.  We are moving from an under-developed to a developing nation and finally towards a developed economy when we are able to provide basic amenities and a certain standard of living to our teeming millions.  In this process, various Indian companies which participate in this process will ultimately stand to benefit due to rising demand for goods and services.  If we can be part owners of these growing businesses through participation in their equity, we also stand to gain as investors.   No country in the world today offers a better investment rationale than India.
How to participate in this wealth creation journey through equities?
For sophisticated investors buying the stocks of the companies is the first choice.  Direct equity participation calls for more active investment management in the form of identifying companies which are fit for investment, ability to visualize how the industry in which a company operates would progress over long periods of time, closely following up on their performance on a quarter on quarter basis, understanding when to exit to maximize returns etc., Sounds too cumbersome and demands a professional fund manager who can do it for you, right?
That’s exactly, Equity investing through mutual funds is all about.  It offers a wonderful opportunity to participate in this wealth creation opportunity.  Mutual Fund offers professional investment management with proven delivery of results over the last 20 odd years.  It is a very passive activity and requires minimum or no major effort from you, the investor.
Historical Returns of various asset classes: 
We have recorded history of last 35 years of Indian stock markets.  The BSE Sensex was created in 1979 with a base of 100.  Today, after 35 years, we are at 28,000.  That is, the money has multiplied 280 times in the last 35 years.  The annualised return on the sensex is 17%.
Compare that other asset categories over the last 35 years:
Fixed Deposit – 8.41% – the money has multiplied 16 times
Gold – 9% – the money has multiplied 20 times
Sensex – 17% – the money has multiplied 280 times
You should also note few important points on the above returns.
1.  The returns on FD and Gold are pre-tax and after taxes it would be even lower.
2.  The equity investments attract no tax in India and therefore the equity returns remain at the same level.
3.  Equity returns from Sensex is 17% and the returns on actively managed mutual funds have managed to return anywhere between 20% to 22% over the last 20 years period (since private mutual funds are introduced in India).
4.  The inflation during the period 1979-2014 is 7.57.  Post inflation returns are very low for FD and Real Estate over long periods of time
Price Volatility:
The unique thing about equity investments is that the price is very transparent and it is made available on a daily basis.  Naturally, when a particular commodity is traded day-in and day-out, there are bound to be price volatility due to various reasons like macro economic factors, political developments, global economic developments etc., The price volatility is part and parcel of equity investing and you should not be worried by it.
Remember, the returns of 17% or 280 times multiplication of Sensex happened over the last 35 years in spite of various economic and political developments both in India and abroad.  To name a few, the key negative developments which we witnessed during the last 35 years include:
  • Harshad Mehta Scam in 1992
  • NBFC Fiasco in 1995
  • Asian Financial Crisis in 1997
  • Dotcom bust in 2000
  • 9/11 terrorist attacks in 2001
  • Failure of BJP Government to get re-elected in 2004
  • Sub-prime mortgage crisis 2007
  • Lehman failure 2008
  • Quantitative easing 2009
Couple of them are directly related to the Indian stock markets.  The volatility is bound to be around in the future as well but the ability of equity to produce inflation beating returns of equities can’t be ignored over long periods of time. In the short term, there are possibilities of making negative returns but if you hold for longer periods (10 years and above), there is a very low possibility of making any negative returns.
Conclusion:
The real wealth creation happens when your investments produce inflation beating returns over long periods of time.  One of the asset classes which can help you build wealth is equities.  From the point of view of diversification also, it is important that you invest in all asset classes like FDs, Real Estate and also equities.
For a long term goal like your retirement corpus creation, equity would be an excellent investment avenue for you.
It is safe (in the long run), transparent, highly liquid, provides tax breaks on your income (like ELSS) and finally tax free! What more do you require to choose an investment!!

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